Webcast replay: The changing state of estate planning
October 17, 2013
Replay and transcript from a recent Vanguard webcast
While estate and gift tax rates and exemptions were settled late last year, recent Supreme Court rulings on the Defense of Marriage Act and same-sex marriages—along with differing laws in some states—still make estate planning a challenge.
In this live video webcast aired October 3, 2013, financial planners Alisa Shin and Kevin Wick of Vanguard Asset Management Services™ provide some common-sense answers to complex questions, and explain why it's always a good idea to review your estate plan if you have one or establish one if you don't.
Gary Gamma: Well, good afternoon everyone, and welcome to this live Vanguard webcast. Whether you're watching us on the East Coast, West Coast, or wherever, and regardless of how you're viewing the webcast—from a computer, tablet, or smartphone—we're happy to have you with us.
I'm Gary Gamma, and today we're going to discuss what we call the "Changing state of estate planning," and there's plenty to talk about considering all of the factors that can affect the way you create and manage your estate plan.
For instance, legislation enacted in the beginning of this year changed the game on estate tax rates and exemptions.
More recently, the Supreme Court has reinterpreted the Defense of Marriage Act which has implications for same-sex marriages.
So after viewing this webcast, we'd like you to have a better understanding of the impact of these recent legislative and judicial changes, how you can use estate planning as a valuable wealth-management tool, and why it's a good time to review your estate plan or establish one if you haven't already done so.
Now complex topics require some commonsense explanation, and we're fortunate to have two Vanguard experts to help us make sense of it all. Senior wealth planners Alisa Shin, and Kevin Wick. Alicia, Kevin, thanks for being here.
Alisa Shin: Thanks for having us.
Kevin Wick: Thank you.
Gary Gamma: So we'll get started shortly by chatting with our panelists but, as always, this webcast is about you and your questions which are pouring in already. We'll spend most of the broadcast answering those questions, and we'll continue to take them during today's event.
You can also send in questions through Twitter by simply using the #VGLive. Sound good?
Kevin Wick: Very good.
Gary Gamma: Okay, terrific. But before we get into our discussion, we'd like to ask our audience a question. On the right-hand side of your screen, you'll see our first poll question which is, "Have you reviewed or revised your estate plan in the last two years?" Take a moment to answer the question. If you can't see the poll, please check to see if your browser's zoom setting is at 100%. So go ahead and respond, and we'll check the results in just a few minutes.
So while we're waiting for you to respond, let's take a moment to survey the landscape. We did a webcast on estate planning almost exactly a year ago amidst great uncertainty.
Kevin, you were there. Can you tell us what's changed and what it means going forward?
Kevin Wick: Definitely. It's good to be back under a little bit different circumstances. From a planning perspective, a year ago we were in a very uncertain world. From a legislative tax planning standpoint, there was a lot of question as to where things were going to be going forward. And we were faced with potentially the fiscal cliff issue and what impact that would have on our tax laws.
As of the beginning of this year, we have certainty, and that's a good thing when it comes to planning. Certainty, it gives you a basis to, a knowledgeable basis to work forward from.
So that's a big difference from a year ago. And in today's discussion we hope to touch on where we stand today, give sort of that basis that we can work from going forward, and talk about what changes or what things might need to be looked at and discussed from this point of certainty going forward.
Alisa Shin: Yeah, absolutely. I mean, we were—Kevin's right—we went from complete uncertainty to the first time in almost 12 years of having as much certainty as we've ever had in the estate planning world. And there's things that we had been talking about a year ago that some of our clients took us up on in terms of making lifetime gifts, taking advantage of the exemptions that we thought might be vanishing. Some clients did it, some clients didn't do it. And hopefully, today, we can talk a little bit about what decisions were good decisions, bad decisions, and hopefully they're all good decisions as long as folks made the decisions for the right reason and not just because of taxes.
Gary Gamma: Okay. Excellent. Well we know we'll have lots of questions. Before we get started, let's take a moment and see how the audience responded to the first poll question. Have you reviewed or revised your estate plan in the last two years?
It looks like 40% said yes, 42% said no, and about 18% said they do not have an estate plan currently. Is that about what you expected?
Alisa Shin: Yes.
Kevin Wick: Yeah. I think what it tells us is we have a number of people without a plan that, hopefully, are listening today and we can give them some guidance on steps to take going forward. I think we saw, again, with the big sort of influx situation last year, we had people who had a difficult time making a decision which would lead to sort of the 40/40 on each side of the fence there.
Alisa Shin: Right. Yeah. I think the uncertainty for a lot of our clients was enough to make them do nothing until we did have some certainty. And so, hopefully, after this webcast, we'll help clients get motivated to actually dust off those plans and take a look at them.
Gary Gamma: Okay. Well, before we ask some questions, let's just take a quick look at the next poll. And that is, "What concerns you most about your estate plan?" And we've got a few answers to choose from here: My beneficiary's ability to responsibly handle inherited wealth; the potential impact of outside influences on my beneficiaries; the impact of a beneficiary's divorce; a beneficiary's creditors getting to the inheritance; taxes; or, no concerns.
So, again, take a moment and answer that poll question, and we'll go ahead and go to our first question which comes from Clifford in Somerset, New Jersey. "I executed all the typical estate planning documents, wills, etc. five years ago. What has changed that would make me want to make any changes?" Alisa?
Alisa Shin: Well, actually, so five years ago, that was back in 2008, and we were in a world where in 2008, had you passed away, your estate tax exemption, the amount that you could pass free from the estate tax was only $2 million per person.
Today, in 2013, with the new tax laws that came into effect in January of this year, that number is now $5.25 million. So there's been a significant change in the tax law since then.
I believe that there should be a chart popping up on everyone's screen that kind of outlines the changes that were made with the American Taxpayer Relief Act of 2012, that new law that was signed in January of this year. And, basically, what this law did was took us where we were in 2012 with some slight adjustments. What it did was it made permanent the estate tax exemption of $5 million, as well as made permanent the annual inflation adjustment. That's why it's now $5.25 million. It was increased by $130,000. It also, that same exemption number for the gift tax and for the generation-skipping transfer tax as well.
The one thing it did do from a change standpoint is it increased the tax rate from 35% to 40%, and that's what the top tax rate is for the estate tax, gift tax, and the GST tax.
So, to answer the question there, there have been significant changes. Depending on what your net worth is, it's a good idea to take a look at it, see what your plan is, how it needs to be adjusted given the higher exemption amounts, especially if you've done a plan that says that you're giving your exemption amount to certain people or trusts. You want to make sure that increased exemption amount—and keep in mind, that's going to increase every year, so those individuals or trusts will keep getting more—you want to make sure that that number doesn't get to be more than what you want it to be
The second thing is it's been five years. Our general rule of thumb is that it's always a good idea for clients to review their estate plan every three to five years; I say three years, especially if you have a life event, and certainly three years the older that you get. It's a good time just to dust it off, make sure that your goals and objectives are still consistent with what your documents say.
Gary Gamma: So now that we have a lot of clarity it's a great time to take another look. Kevin?
Alisa Shin: Absolutely.
Kevin Wick: Yeah, I think that's the main point now with clarity and having really a—it's a significant legislative change even though we're seeing some similarities to where we were just two years ago, with that clarity, with that permanence, if you will. This is a good time to take a look, a snapshot. Does what I have in place that might have been done a few years ago, or a number of years ago, does it still do what I want it to do given our new landscape as of this year?
Gary Gamma: Okay. Great, let's take another question. We have one here from Doran from Boston. "Aside from the $5 million estate tax exemption, yearly $14,000 gifts to individuals and 529 plans, any other easy ways of transferring wealth to your family?"
Kevin Wick: The ability to make gifts tax-free, which are the two examples that he gave there, are really the easiest way, and easy for a number of reasons. One is there is no tax cost when you fall into those parameters. And, secondly, at least for the annual exclusion gift, that $14,000 a year number, there's also no need to actually file a return or really document that with the IRS.
When you give the larger amounts and you start using the exemption amount, that requires a tax return. Still no tax due but requires a filing. So those are really the easiest ways when you're talking about transferring wealth during lifetime.
Transferring on death, that involves the steps of the planning, your wills and trusts that we're talking about today. So, really, he's identified the two easiest ways, if that's the crux of his question, yeah.
Gary Gamma: Okay, great. Let's go ahead and see how our audience responded to the second poll question. So, again, the question was, "What concerns you most about your estate plan?" It looks like—remember, there were a lot of answers here—the biggest selection, 48%, went to taxes. The next biggest chunk at 28% was the concern that my beneficiaries are going to be able to responsibly handle the inherited wealth. Then we had 10% worrying about the potential impact of outside influences on the beneficiaries. About 4% the impact of a beneficiary's divorce, and just about 2% beneficiary's creditors getting to the inheritance.
Any surprises there, any comments?
Alisa Shin: It is a little surprising. I had expected the number being higher for the ones who were concerned about divorce because my—at least the conversations we have with our clients—that seems to be an overriding concern, just because of the divorce rate as high as it is in the U.S., you just never know what happens. You hope for the best.
But I think what that does show is that there are a myriad of concerns that clients have, some of which are not tax-related, although taxes was a big part here. So even though, as we kind of went through with that first question, you saw on the tax chart, you know, the exemption rates are so high a lot of clients say, " ou know what, it's $5.25 million between myself and my husband. I can get $10.5 million out of my estate tax free. I don't have that much. I don't have to worry about estate planning."
Kevin Wick: And, hopefully, those who are concerned about taxes will come away from today's discussion knowing that with the exemption amount as high as it is and getting higher incrementally year over year, the reality is the vast majority of us don't have to be concerned about estate taxes. And that's a good takeaway for many of those people concerned with taxes.
Gary Gamma: Right. Okay, well let's get back to the questions. We have a question from Ronald in Illinois. "Need I be concerned with an estate plan if my estate is well under the $5 million exemption now?"
Alisa Shin: All right, you know, that's a great question because at the federal level, on one hand, you don't have to worry about the estate taxes today. But with that being said, if you live in a state that does have a state estate tax, which Illinois is one of them,I think we might have a chart up there that will at least give a sense of what states have either an estate tax or an inheritance tax.
In most of these states that do have their own state estate tax, the threshold of how much you can give free of estate tax at the state estate tax level is lower than the federal amount. I don't remember off the top of my head what Illinois is, but I know it's certainly less than $5 million. So even though you don't have a federal tax issue, you might have a state tax issue which is a good reason to go see an attorney, an estate planning attorney in the state that you reside in so they can help you make sure that you're minimizing that tax or at least deferring that tax for as long as you can.
The second reason though is even if you didn't have a state estate tax issue, regardless of what your net worth is, you have to really think through who you want your money to go to, if you have concerns with any of those beneficiaries. If so, you definitely need to talk with an attorney because you likely won't want that beneficiary to receive their inheritance outright. And if you have specific people you wanted it to go to, you want to specify that in your will or your revocable trust.
If you die without a will, your assets will pass pursuant to the intestate laws of the state that you are a resident in at your death. And the intestate laws might not give your assets to the people that you want it to go to.
Gary Gamma: Excellent. So if you saw your state on that map, it's definitely an alarm bell to check and see what's going on with your state.
Alisa Shin: Absolutely.
Gary Gamma: And we're lucky enough to have an inheritance tax here in Pennsylvania.
Alisa Shin: That's right.
Kevin Wick: Lucky!
Gary Gamma: Kevin, you're from Arizona, you don't have to worry about that.
Kevin Wick: We're lucky enough to not have to worry about that. Exactly.
Gary Gamma: All right. Well then, the next question comes from Laura in Greenwich, Connecticut. "With the portability election, is it still necessary to keep $5.2 million of assets separately in each spouse's name?" Alisa?
Alisa Shin: So, let's take one step back to explain maybe what portability is. Maybe many of our clients aren't familiar with it. Portability is a new tool that Congress gave estate planners in their toolbox to help clients with their estate planning.
What portability says is that should one spouse pass away without using all of their federal estate tax exemption, the executor of that spouse's estate could elect to give the surviving spouse the unused exemption of their deceased spouse. So let me kind of boil it down to numbers.
If we have a husband who passes away and only has $2 million worth of assets in their name, meaning that they have $3.25 million of estate tax exemption remaining—the difference with $5.25 million and $2—the executor could give that $3.25 million through an election that's made on the estate tax return to the surviving spouse. And then the surviving spouse now has an estate tax exemption of $8.5 million, if I'm doing my math right.
So it's a great tool because it's a save for a lot of our clients that we didn't have in the past. Because, in the past, if those clients hadn't done proper planning or didn't consult with an attorney, or didn't follow legal advice, or got bad legal advice, and wasn't able to use the first spouse's full exemption completely at that person's death, the family just lost the unused amount.
Portability now allows families to be able to take fully advantage of the entire amount. That's how it works. There's a lot of details to it, but that's generally how it works.
But to answer the question, I'm afraid that my answer is it depends. It depends on what your goals are, it depends on who you want to give the money to, and it also depends on what you think you might want to do on a personal level after your spouse passes away.
So let's take the first one. It depends on what your goals are. If you're trying to do generational tax planning to shelter money from future taxation as it passes from generation to generation, you don't want to rely on portability because portability only applies to the estate tax exemption. It does not apply to the generation-skipping tax exemption, so you would lose that.
The second thing to consider is portability is based on you only get the unused exemption of your last spouse. So if you were married to husband one and you got his $3.25 million exemption, and then you remarried, and then you survive that husband, you technically lose—not technically, you do lose—your first husband's $3.25 million. It doesn't matter whether or not the second husband used up his entire exemption, gave you his exemption, or didn't give you his exemption, you'll lose your first spouse's exemption.
So, unless you want tax laws to essentially social engineer your life, you really, we really suggest to clients as a default rule to still stick to traditional planning just to keep your options open in terms of generational tax planning, in terms of what you want to do with your personal life.
And the other part also is, is that while portability was made permanent with this ATRA in January of this year, we don't know if it's permanent forever or if it can ever be taken away. So I think it's just a good idea to be more on the conservative side and do the right planning upfront so that things go exactly the way you want to go, regardless of order of death, regardless of if you marry again or not.
Gary Gamma: Kevin, let me get you in here. There's also a follow-up question I think that might apply. It says, "Does the portability feature only apply to a spouse?"
Kevin Wick: It does. And it applies to a spouse and one of the other sort of recent changes that we'll get to, I think, in some of our further discussion, is same-sex spouses. And so, now, with the guidance, U.S. Supreme Court decision in June, and guidance that's come from the IRS since then, basically, the same treatment that traditional spouses would receive under the federal tax laws is going to be extended to same-sex couples when they've been married in a state that recognizes that union.
And so, absolutely. It does apply to spouses, although we have sort of a wider cast, cast a wider net of spouses, if you will, than we would have say a year ago.
Gary Gamma: Well, keeping with the portability, there's a question here from Wayne Key in Princeton that says, "The estate tax exemption portability has become permanent. Is an A-B trust still necessary for someone with less than $10 million in assets?"
Kevin Wick: Yeah and to Alisa's point before, you need to look at a little bit bigger picture and not let the tax situation alone control your planning. And so the answer would be yes, there is absolute application for the typical or traditional A-B planning, even with these high exemptions, even with portability. Taxes are not the sole reason. And, again, for most of us, if we're not even subject to the estate tax, it's not a primary reason for planning. There are so many other reasons for doing the planning. Making sure the assets are getting to who we want to receive them, in the way we want them to, at the times, in the amounts, and all kinds of—
The second poll question related to some of what I refer to as sort of the protected features of planning. If you're concerned about a beneficiary's ability to actually handle their inheritance. If you're concerned about creditors or potential for divorce, those are all reasons to do the more traditional A-B trust planning. So it definitely has application even in today's world.
Gary Gamma: Great. Next question is from Donna from Yelm, Washington. "What options would you choose when your state estate tax threshold is considerably below the federal threshold? Use Oregon at $1 million or Washington at $2 million as examples."
Kevin Wick: It's interesting because if we turn back—and Alisa's touched on the state tax issue a moment ago—if we turn back say four, five years ago, state-level estate tax planning was much less of an issue because there was a closer connection between the federal law and the state laws.
That has gone away in recent years, and so there is, in some states—and we've got the chart available again—in some states there's a real big dichotomy between the federal statute and the $5.25 million of exemption amount and what exists in other states. And those two examples given in the question illustrate that dichotomy. You've got a big difference, which means that assets that might not be taxable under federal law, could be taxable under your state law, if you have that smaller $1 million or $2 million exemption amount.
So, again, if you're one of those states, it's imperative to look at your planning presently to deal with that. And so there may be another step or another layer of planning added to deal with that, and that's, again, something that's relatively new. In years past we didn't have to look at that as much as we do today.
Alisa Shin: Absolutely. The other, in terms of what you can do, every state that has their own estate tax has created it in a different way with different exceptions to it. So there are some specific very similar A-B planning that you can do at the state level to defer the tax. Some are more generous than others. But that's something you should certainly talk with your attorneys about.
The other thing to consider, again depending on what your goals are, and always keep in mind that any estate plan should always, hopefully, ensure that you and your spouse have enough assets to live your retirement life in the manner that you would like.
Given those two things, what some clients do do is start making some lifetime gifts to try to reduce their state estate tax exposure. Most states do not have a state gift tax with the exception of Connecticut and Minnesota. So if you don't live in Connecticut or Minnesota, you can certainly make some lifetime gifts and not incur federal gift tax necessarily, depending on how much we're talking about, but also not incur state gift tax, and it would likely get those assets out of your estate for state estate tax purposes.
Gary Gamma: I think the portability issue I think is clearly on some people's minds here. There's another follow-up clarifying question. "On the portability question, there is an unlimited limit on taxes for a spouse, so no exemption was used in the example given. You need to correct that or correct my understanding."
Kevin Wick: Well, the question is correct. So if you have it transferred directly from deceased spouse to surviving spouse, or to a trust that is benefiting solely that surviving spouse, then there is an unlimited marital exemption, which means that you can pass an unlimited amount of assets without using any of your estate tax exemption. And so they're correct in that.
Now what portability then allows you to do in that scenario is "port" or transfer over the unused exemption to the surviving spouse so that it would be used on the death of that surviving spouse. And so, that's absolutely correct as far as that understanding.
There may be reasons for not relying on that, that we talked about before. One of them is if you use the exemption earlier, using the traditional A-B trust planning, then you captured these amount of assets that will never again be subject to estate taxes. As those assets grow, they get bigger, still not subject to estate taxes.
If you use portability and sort of defer the taxation until the surviving spouse has passed, those assets may have gotten bigger which means either you may not have enough exemption left and then may be subject to the estate tax at that point.
So there are multiple reasons for actually using the more traditional planning, but the questioner is correct as far as how portability works.
Alisa Shin: Just to kind of tag on to what Kevin was saying, in the example I had given, if you make an assumption that the $2 million goes into what we're calling the B trust, the credit-shelter trust/bypass trust, you would, in fact, even if that trust is designed for the surviving spouse's sole benefit, you would still use $2 million of the decedent's estate tax exemption. So how much exemption you actually use is really dependent upon how the assets are titled, who beneficiaries are of those assets, if they're retirement accounts or annuities or life insurance, as well as how the estate plan is set up, meaning the will or revocable trust.
So he's right. There's a possibility that it could be a full $5.25 million that would go to the surviving spouse, but it could also be a $3.25 million that goes to the surviving spouse.
Gary Gamma: A great example of why we should seek out professionals to navigate through these things.
Alisa Shin: Exactly.
Gary Gamma: Maybe we could step back a second. I think we have another clarifying question here from Melissa in California. "What is the difference between estate tax and inheritance tax?"
Alisa Shin: We get that question all the time. So technically—well let me say this— practically speaking, there's not much of a difference. The money still gets paid to the government. Technically speaking though, the state estate tax—the estate tax is essentially a tax on the right to give your assets away. The assets that you accumulated, that's the tax that gets imposed on it.
Inheritance tax is kind of the reverse. The inheritance tax is essentially a tax on the right to receive assets. And typically an inheritance tax is levied based on what type of relationship the beneficiary has to the decedent. So, for instance, Pennsylvania in the chart that we had showed up there, shows that Pennsylvania only has an inheritance tax. So in Pennsylvania, if you are a spouse, it's 0%. If you're a charity, it's 0%, if you are a lineal descendant, a child or a grandchild, it's a 4.5% tax. If you're a sibling, it's a 12% tax. If you're basically anybody else, it's a 15% tax. Whereas the state estate tax is typically just a tax based on what assets you had accumulated during your lifetime and are subject to estate tax.
Kevin Wick: Yeah, and since you've got that sort of lineal family connection, in theory, an inheritance tax could be less burdensome than a state-level estate tax which comes across the top based on the assets regardless of who it's going to with the exception of the spouse. So there can be certainly that instance where the inheritance tax is a little less of a burden.
Gary Gamma: Okay. Well the next question, changing gears a little bit, Alisa, it might be for you; we were talking about this before the show. With the dismantling of parts of DOMA, the Defense of Marriage Act, what are the estate planning implications for newly married gay couples?
Alisa Shin: Well Kevin had hinted at some of it. Basically, with what's called the Windsor case now, the Supreme Court declared unconstitutional a section of the Defense of Marriage Act, DOMA, and that section had basically defined a marriage to be between a husband and wife, a male and female. The U.S. Supreme Court has said that was unconstitutional and could apply to same-sex couples. And the IRS and the Treasury Department, probably about a month ago, released guidance in terms of how they were going to implement that Supreme Court ruling. And that basically now says that if a same-sex couple gets married in a state that recognizes same-sex marriages, regardless of where they reside, whether the state that they reside it recognizes marriages or not, the IRS will treat them as married, similar to that for a heterosexual couple.
It only applies to marriages; it does not apply to civil unions or domestic partnerships or any other sexual arrangements. You have to be married.
So if you are in that situation, it's a good idea now to meet with your financial advisor, with your estate planning attorney, your accountant, what have you, to figure out what your estate plan should look like. Should you do the A-B trust? Should you move assets into your spouse's name? In the past, that would have been subject to a gift tax or used up a large part of your exemption. But now because of the unlimited marital deduction, you can freely make gifts to one another and do your estate planning to ensure the assets are in each of your names in the appropriate amounts.
So it's looking at that. It's figuring out should you be doing tax planning today now that you do have the unlimited marital deduction and use both of your gift tax exemptions today? That wasn't available last year.
The other thing to look at, if you aren't married yet, is to take some considerations about what steps you need to do before you do get married. Same things that we would have conversations between a heterosexual couple who were recently engaged. Should you have a prenuptial agreement? Are there certain things that you should clean up before you get married from an income tax side of things typically? Those considerations are all things a client should now consider before they get married and certainly embark on doing what I'll call traditional estate planning that was always available to heterosexual couples.
Gary Gamma: Kevin, anything to add?
Kevin Wick: The world of tax and estate planning has really been simplified for same- sex couples. And, again, the emphasis is on if you've been married in a state that recognizes that union. We've got roughly 12 or 13 jurisdictions that do. Doesn't matter where you live thereafter, but if the marriage occurred in a state that recognizes it, then you're going to get, again, the same treatment that a traditionally heterosexual couple would get under the federal tax laws. That's going to simplify things and open up planning options, as Alisa said, that weren't available before.
Gary Gamma: Okay. Well this question is in the same theme from Darrell in Ohio. "What are your recommendations, general and/or specific, for same-sex spouses who are formulating estate plans? I live in a community-property state, if that makes a difference."
Alisa Shin: It could make a difference. What's complicated now for same-sex couples— while Kevin's right, it has simplified things on one level, the federal level—if you live in a state that does not recognize same-sex marriages, then there's an added complexity to it because you won't be treated as a married couple for state estate tax purposes. So you really need to make sure that your estate plan factors that into, takes that into account as you design the plan. So things like the unlimited marital deduction for state estate tax purposes won't be available to you. So it's very likely that the first spouse's death, a state estate tax will have to be paid at least for the time being. So you want to make sure that there's enough liquidity, you want to make sure there's enough assets for the surviving spouse, and any children you might have, to live on. So that kind of analysis needs to be done.
The other thing to keep in mind is, not necessarily the tax laws, but the other what I'll call estate and trust laws. Arguably in those states that do not recognize same-sex marriage, they're not necessarily going to interpret the word "spouse" in what's now becoming the new way, I'd say. So that if you were relying on intestate law, a spouse might not be considered your husband if you're in a same-sex marriage. So that's why it's important to make sure that you have a will and estate plan in place.
Health-care decision-maker—it's the same thing. Unfortunately, it would be the same issues that we had pre the Windsor case that they have post-Windsor. So it's definitely for the clients who live in a state that does not recognize same-sex marriages. It's still a little bit complex and might require you to have a little bit different plan than our clients who live in a state that does recognize same-sex marriages.
Kevin Wick: I think it's important to be proactive. While things have been simplified at the federal level, there are definitely, as Alisa was speaking to, elements that still provide or present issues. So being proactive in your planning.
Another element or consideration to bring into that mix is if there are children in that relationship that have been adopted in, whatever the case may be, how different states look at those adoptions whether a second parent is legally able to actually adopt that child. Those present planning issues if something were to happen to one of the parents, one of the spouses. All of those issues mean you need to still be proactive in your planning, especially in that circumstance.
Gary Gamma: Good point. Tim from San Francisco sent in a question. "What impact will all of this have on couples with more than $11 million in their estate? Is there something they should be doing above setting up a trust to maximize current exemptions?"
Kevin Wick: Yes. So if you are one of those people who are potentially subject to the estate tax, so if you have sufficient assets—$11 million in today's world would qualify you for that—one thing to think about, we touched on it earlier, is to know that the exemption amount is indexed for inflation so that would go up year-over-year under current law. As assets fluctuate, you may be able to simply meet your asset level by the exemption of going up. Maybe not something you want to simply rely on though. And the gifting idea that Alisa mentioned before is a typical planning option that we talk to clients about when they are exposed to the estate tax both at the federal and state level.
And so transferring assets during a lifetime on to family members, whoever it is that you want to give away assets to, reduces the value of your estate, means less subject to the estate tax at whatever point in the future that comes into play. And the other planning benefit of gifting away assets during a lifetime is then the growth of those assets while otherwise would have been part of your total estate are now gone. So the gifting idea would be one of the primary planning ideas.
Charitable gifting during lifetime would have the same effect, reduce the amount of assets that could be subject to the estate tax down the road. But moving assets out to the extent that they're comfortable, to the extent that it fits with their overall wealth and retirement plan, make sure there are sufficient assets for their own needs during lifetime—all of those elements come into play. But, definitely, at that threshold you need to be thinking about what impact does the estate tax have on our family situation?
Gary Gamma: I'll make sure to bring the gifting topic up with my parents next time I talk to them about estate planning.
Kevin Wick: Absolutely.
Gary Gamma: Anything to add on that?
Alisa Shin: Yeah. I think the other consideration or the option they have is also think about life insurance. If you have a taxable estate, life insurance, not from an investment perspective but from an estate tax perspective, can be a good tool to use for wealth- replacement purposes. So there are ways to design the purchase of a life insurance policy and the payment of the premiums so that the death benefits would not be included in the insured's estate at death. So it essentially goes estate tax-free to your family.
And if you get the right amount and you design it the correct way, it doesn't necessarily need to go into a life insurance trust; or if it does go into a life insurance trust, the death benefits do not necessarily have to stay in trust for the beneficiary's lifetime. You have flexibility about what you do with that. But if you have life insurance, and it's owned by someone other than the insured, the death benefit should not be included in the decedent's estate. So it's a great way to reduce estate taxes. You just have to be comfortable with paying the premiums, and make sure you do the due diligence and analysis to make sure it makes sense.
The other thing I would add is, you know, even if your estate is worth more than $11 million, especially with the increasing estate tax exemptions, at Vanguard we really encourage clients to take one step back and really think about what their goals and objectives are, what their family values are, what are you trying to accomplish. If all you're trying to accomplish—and I say "all" a little bit tongue in cheek—is, you know, to pay for your kids, your grandchildren's education, provide them annual exclusion gifts for their lifetime to help them out a little bit, and maybe you're thinking that you might just leave them—and I use the word "might" in quotations or just little—you might leave them $5 million to split between the two of them, then arguably you don't need to do anything during your lifetime because there's between you and your spouse, you have $10.5 million that you can give away tax-free. And if you're only going to leave them $5 million, your family, you don't have to worry about it. Everything else is going to charity.
So just taking that step back and thinking about what your goals and objectives are is really important because if you don't do that, you could end up on a path and be doing all these things that really aren't necessary and add a little bit of complexity to your life that you don't need and that might, I don't know, mire your retirement years in a way that you could be spending that time differently. So taking that step back and looking at your goals and objectives is an important part of it.
Gary Gamma: Yeah. I had a participant tell me once that my goal is to live long in retirement and have my last check bounce. So it's a good point to really start with the goals and then work through the process.
Alisa Shin: Right, exactly. But you actually raise a good point. The best tax planning you can do is spend and enjoy the money, as you said. It's hard to spend every dime before you die or every penny. And the other thing is that if that is your tactic, you want to make sure you're spending it on fungible goods, I guess, if that's a word. If you buy boats and cars and houses, those all have a value that's going to get included in your estate and get taxed. You have to do it on food, trips, even bottles of wine I would say because if they're expensive, they're going to be included in your estate.
Kevin Wick: Yeah, right.
Gary Gamma: Okay, well the next question, this is a good one. This is one I get a lot when I travel. I'm sure you hear this all the time as well. It's from Keith in Orlando, Florida. "At what dollar value of assets is an estate plan necessary? And then also, If you have beneficiaries named on your various accounts, what's the point of the estate plan?"
Kevin Wick: It's a very common question, absolutely. And there isn't a magic dollar threshold by any means. We talk a lot about the tax impact of things. But the broader point is looking at starting from what are your goals and objectives? What are you looking to accomplish with the wealth that you've accumulated, whatever that number is, and being able to find a plan that achieves those goals. And that can be through setting up your will, setting up a trust. It can be through making gifts during your lifetime. It can be through making gifts to charity. All of those options are on the table.
Certainly with respect to assets or accounts that have a beneficiary designation attached to them—your retirement accounts, life insurance, annuities—those beneficiary designations are going to control. Those are going to direct those assets based on what you've set up in that designation. But those are only as to those assets, so you still need to plan for everything else that exists outside of there.
It's possible to set up taxable accounts—your bank accounts, your money market account, things like that—with a beneficiary designation, but that's not necessarily the sole answer. Again, there will be things that aren't covered by that. So you need to take a very holistic look at things. Everything that you're looking to accomplish, everything that you own, that's what we're talking about in terms of an estate plan. Not just what does my retirement account say where it's going to go, what does my will say—a lot broader than that.
Gary Gamma: Right. And as you discussed, it also depends on what state you live in because you've got to look at the state laws.
Alisa Shin: Yeah. Absolutely.
Gary Gamma: Okay. David from Massachusetts, writes, "How does Vanguard Asset Management Services deal with trusts giving discretion to the trustees to support something like education for grandchildren?"
Alisa Shin: So my answer to that, again, is it depends. But to give a little context, Vanguard does have a trust company. It's commonly called Vanguard Asset Management Services. Legally it's called Vanguard National Trust Company. We do offer trustee services. And one is where we actually do serve as a sole trustee or a co-trustee of a trust.
Short answer is as long as the trust gives the trustee the discretion to use either income or principal or both for a grandchild's education, you know, depending on what parameters is put on there, we will certainly follow the rule that's set forth in the trust. And if a grandchild needs money for education, we will certainly make that payment from the trust.
Again, typically your trust sets up the roadmap, sets up the rules that we have to follow, and we will follow those rules. So you want to make sure it's as flexible as you want it or as restrictive as you want it—it can go either way—but whatever you say in that document we would certainly do.
So if, for instance, the document said we could only use the income and principal for a grandchild's postsecondary education, and the grandchild came and said, "I want to go to a private prep school, high school," we wouldn't be able to pay the tuition there. But if they were going to college or a grad school, arguably we could. So it all depends on how the trust is designed.
Kevin Wick: Yeah. And as Alisa mentioned, any trustee, whether it's Vanguard or otherwise, is charged with following the rules that are set forth therein. And her example is great as to why you might consider being more broad, more discretionary, more flexibility. Because if there was in that example a real desire or a real need for that grandchild to go to a private school for whatever those circumstances might be, drafted one way you might not be able to do it; drafted another way that trust would allow for that. So flexibility oftentimes is a very good route to go down when you're considering your planning.
Gary Gamma: Alisa, I think this question might be right up your alley. It's from Mel from Vista, California. "How do you screen estate planning lawyers?" Don't say depends.
Alisa Shin: Yeah. It kind of does. No. You know, there's a lot of different ways to screen attorneys. I think that there are three things that you want to look out for. One, and hopefully it's probably—I don't know if it's the primary one, but one of the top ones—is making sure that your estate planning attorney is technically competent, which isn't always easy for nonlawyers to do. So to determine that really based on a couple of things is, you know, not that where you went to school is an indicator of your success of how good you are, but that's certainly one place to look.
Some websites like Martindale-Hubbell have started trying to rate attorneys. I don't know how much credence and how good it is, but that does give you some guide. The other thing is to talk with friends if they've used attorneys to get a sense of what their experience was like, how good the documents were, did they have any problems, those kinds of questions.
There is an organization that's called ACTEC, American College of Trust and Estate Counsel. It's actec.org is the website. And this is an organization made up of estate planning attorneys. Not any estate planning attorney can join ACTEC. You have to essentially be voted in by your peers, so you have to show a certain technical expertise, leadership, thoughts, scholarship. You have to write, speak, so forth to be elected into ACTEC. It is certainly not to say that every attorney that's listed as an ACTEC fellow is technically competent, but it usually is a good indicator that, you know, you might not have to worry about it.
But maybe more importantly than technical competence—I say that a little bit hesitantly—is making sure you're comfortable with your estate planning attorney on a personal level. If you can't open up to your attorney and say, "You know what, my son-in-law drives me insane. He is spending money left and right, or he has an alcohol problem, or my daughter is doing X, Y, Z, or my son is doing A, B, C," they could be the best estate planning attorney in your state, but I would argue that they will be wholly ineffective for you. They're not going to be able to come up with the right plan. So if you can't relate to them, you can't talk to them, feel comfortable with them, they might not be the right attorney for you.
And, lastly, the fees. You want to make sure that you have a comfort level with their fee structure, how much they charge on an hourly basis, if they're on an hourly basis or flat fee, understand what things could change that flat-fee number. Make sure you're comfortable with their fee schedule.
Kevin Wick: And I would touch on that relationship point, that middle point as well. Go into the process not looking at this as a onetime engagement. While you may have a specific task that needs to be done, as we've talked about already, there's a need to look at this plan overall every few years. And things will change from a statute perspective. The laws will change; that will have an impact. You want to find a relationship where you're comfortable going back every so often knowing that you're going to get good, sound advice. So not just a onetime, I'm in and out, pay the fee and I'm set to go. This is something that has to be reviewed, and as things change, as circumstances warrant it, you want a relationship you can go back to and trust in that relationship.
Gary Gamma: Good. Those are good points. Joseph from Massachusetts, wrote, "What is the role of transfer-on-death elections in estate planning?"
Kevin Wick: So we talked before a little, touched on beneficiary designation. And a transfer-on-death is a way of designating a particular account's—attaching a beneficiary designation to typically a taxable account—your bank account, a money market account, your mutual fund account. So where the account allows for that, you set up this beneficiary designation and say, "On my death, I want this account, whatever is there, whatever exists in account X-Y-Z, account 1-2-3, to go here." And you typically would have the ability to add a contingent beneficiary designation so that if the first person is not alive at that time, then it goes to the next.
That has a role and it's something, again, to be considered in the broader planning context. Depending on the assets that an individual has, that could be an appropriate answer to a particular asset, but don't look at that as the sole answer until you've looked at the entire picture. So it's a way to actually designate a particular account or a particular asset in a way that you want, but should not be looked at alone as the one answer to your estate plan.
Alisa Shin: And I would just add, you know, if you're going to use a TOD account, be sure you understand what limitations you have in terms of who you can identify as beneficiaries. So, for instance, at Vanguard, you can certainly name your children as your beneficiaries, but one thing Vanguard's TOD accounts do not allow is for you to have what's commonly called a per stirpital distribution, meaning to say, "It goes to my children equally per stirpes," meaning that if one child predeceases you—let's say that you have three kids—then that child's one-third share would automatically go to that child's living children, your grandchildren.
Vanguard doesn't allow you to say, "per stirpes" to have that happen. So if one child predeceased, the other two children would split it 50/50. So you have to be sure that if you're going to use a TOD account, your goals can be effectuated based on whatever limitations are put forth there.
And the other thing I would caution is people use TODs automatically because they think they're going to, you know, because they want to avoid probate. And that's a perfectly fine thing to do if you want to make life a little bit simple. But, again, the things that Kevin said, that I had mentioned about making sure it really matches up holistically with your plan is important.
But the other thing I would caution clients is, I don't know, probate, that word has gotten a negative reputation and sometimes unnecessarily so. Every state's probate practice is different. Their process is different. Some are very hard to use, some of them are very expensive, some of them the courts are heavily involved. That's all true. But there's also several states, a lot of states, where that's not the case. And, for instance, Pennsylvania is one of those states where not many Pennsylvanians do things to avoid probate for the purposes of avoiding probate. It's very simple. You can go to the Register of Wills without an attorney. They'll help you there fill out the right paperwork, and you're all set. You've opened up a probate process.
So just because you hear, "You shouldn't do probate," don't panic. Talk to your estate planning attorney, get a sense of what the probate process in your state is like, and just make smart decisions from there.
Gary Gamma: I think we have time for a couple more questions. Beth from Spring Arbor, Michigan, writes, "What are some unique restrictions you've seen in trust funds for children or grandchildren?"
Kevin Wick: Unique. I've been doing this for a while; seen a lot of unique ones. Unique doesn't necessarily mean good or right or well thought out.
Without getting into too many crazy examples, I mean, it's certainly typical to put some rules, some restrictions on, as we talked about before, how assets are to be used and when and in what fashion. And it might be in terms of education. Perhaps you're requiring a grandchild to get a bachelor's degree before they receive a certain distribution, that would be somewhat common. Sometimes I've seen clients put some marital restrictions on things. "You don't get this distribution until you're married."
More unique from that, again, doesn't necessarily mean it's good or right. The more unique, in my estimation, the more unique you get, you're probably getting less flexible. And we talk about kind of the holistic approach to planning. Knowing that things can and will change in the future, we can't predict what that's going to be today. Unique or restrictive planning tools, planning elements aren't going to be flexible by nature. And that may provide difficulties down the road.
Gary Gamma: Right.
Alisa Shin: And I might just jump in. I think with trust planning, there's certainly a lot of different ways to do it. Kevin was kind of leading us down the road, you know, the more unique you make it, the more customized it begins, so one's probably going to cost you a little bit more on the attorney fee end of things.
But, secondly, if you're going to veer away from what I'll call the more traditional trust- design options, you know, I strongly encourage clients to make sure that whatever standards they put in there to make sure that that standard is clearly identifiable, clearly enforceable and can be measured.
So, for instance, I once had a client who wanted to put in their trust that the trustee could buy a new car for the beneficiary once every two years as long as the beneficiary could prove that the beneficiary had gotten no speeding tickets and had not been in any car accidents in the two years during that time.
Well that's a great sentiment, but if you take a step back and think about how your trustee is going to figure that out, it becomes a little bit more difficult. As far as I know, there's no national database about speeding tickets, and there's no national database of car insurance. We can certainly get a report from the insurance company, but everyone knows not everybody reports the accident to the insurance company. So making sure that your standard is clearly identifiable, enforceable, and measurable I think is important.
We've also, on the flip side, had someone say if a beneficiary is a full-time student and maintaining a 3.5 grade point average, then they can withdraw X% of the trust assets each year. Okay, I don't know if that's right or wrong, but I clearly know, and the beneficiary knows, what they have to meet, what a full-time student is, they have to show a 3.5 grade point average. That's something that can be done fairly easily. So you just want to make sure that your beneficiary knows what they're expected of them, and your trustee knows what they're supposed to do and what they're not supposed to do at what moment.
Gary Gamma: Good. Well I think this might be the last question; it could be a fun one. It's from Kim in Paramus, New Jersey, who writes, "What is the best state to retire in from a tax and estate perspective?" Obviously, our legal team would not want us advising people where to move, but, certainly, I'm sure you have some thoughts about this.
Kevin Wick: You know, if taxes are a primary concern, and hopefully we've carried the message that it's not necessarily taxes being the primary concern for everyone. There may be situations, but in most situations there are more pressing concerns than taxes. But if it is a primary concern, then there are different thresholds of taxes from state to state. There are taxes with low or no income taxes. That could be a benefit in retirement. As we've illustrated before, there are states with no estate taxes.
So, again, I caution on making a sort of a lifestyle decision where you're going to live and retire based solely on taxes. But if you're doing a comparison of different areas of the country, then, yes, you could look at that. But there's more to taxes than just income taxes, there's more than just estate taxes. You have sales taxes and property taxes, and all kinds of other things. So you could really kind of mire yourself down in the whole tax thing as that being a driver for your lifetime decisions.
Gary Gamma: Forgetting about things like weather.
Alisa Shin: That's right. That's right. And if you hate living in hot, balmy weather and you move down south somewhere for purposes of minimizing estate tax income tax, well you might have saved your family a lot of money, but you might have been miserable for the last X number of years, through your retirement years living there.
So, as Kevin said, as we commonly like to say at Vanguard, make sure that your tax tail is not always wagging the dog. Like take a step back, and if you're thinking about moving somewhere because of tax reasons, I think I would suggest going down there, renting, go down at different times of the year, try it out first, to make sure it makes sense before you make that commitment.
Gary Gamma: So they didn't tell you where to move, Kim, but they gave you something to think about.
So I wish we could go on, but I think we're out of time now. Alisa, Kevin, thanks so much for your insights. Do you have any final thoughts before we sign off? Alisa.
Alisa Shin: Well, if clients take anything away is we now have, what I'll loosely say, permanent estate tax laws. This is the first set of estate tax laws that we've had in almost 12 years that does not have a sunset provision to it. And based on what we hear from Vanguard's Government Relations group, as well as from colleagues in my old law firm and other places, it seems—I don't have a crystal ball—it does seem that the estate tax exemption and the tax rate is fairly stable right now. That doesn't seem to be up for debate.
Other estate planning techniques, tools, that might be available to us I think are still on the table with Congress, but it doesn't seem like the tax exemption and the tax rate is. So we have permanency. So this is a great time, if you weren't willing to do it the last five years, to pull off your estate plan from that closet shelf, dust it off, take a look at it, and see what things you need to change given where the tax laws are today.
Kevin Wick: And we've touched on it a few different ways in the course of our conversation but sort of the holistic approach to planning, just like to espouse that one more time. That more than just taxes, more than just looking at my will or trust, think about what you have, where you want it to go, why you're doing it, and then look for a simple way, if you can, but the best way to achieve those goals. Take a look back, step back, and from a bigger picture look at the overall plan.
And, again, as Alisa said, this is a great time to do that.
Gary Gamma: Great. Well thanks to both of you for coming.
Alisa Shin: Thanks for having us.
Gary Gamma: Kevin, thanks for coming all the way from Arizona.
Kevin Wick: Absolutely.
Gary Gamma: All right. And thanks to all of you for joining us this afternoon.
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